5 Things Business Owners Should Know About Working Capital Advances

Being a successful entrepreneur is all about balance. You need to ensure that you understand all aspects of your business while keeping your working capital and cash flow in a solid position that lets you take advantage of opportunities as they arise, or keep your business afloat when hard times hit. With 43% of business owners reporting that they have struggled to pay operating expenses, working capital is likely top of mind.

One financial tool that can help your cash flow is a working capital advance, which is essentially a short-term funding solution that helps businesses manage their day-to-day expenses. These types of advances can be secured from a variety of sources, ranging from fintech alternative lenders to traditional banking institutions. Options vary widely depending on their source and their qualifying criteria.

Before you apply for a working capital advance, let’s take a quick look at five things you should know.

1. Purpose Of Working Capital Advances

The purpose of a working capital advance is to help a business meet its short-term operational needs, such as covering inventory purchases, rent, payroll, and other everyday expenses. Using an advance for its designed purpose helps provide liquidity to ensure smooth operations and cash flow management.

You should avoid using an advance outside of these designated expenses, as it can further hinder your business’s cash flow, while also potentially putting your business in a hole that it may be challenging to get out of when your repayment is due.

Businesses that attempt to use working capital advances for extravagant or nonessential luxuries may find themselves struggling to pay back on time. While lavish office parties and state-of-the-art office space upgrades may be great for boosting company morale, these expenses have no direct return on investment that will help to pay back the advance on time.

When using a working capital advance, prioritize funding endeavors that will help increase cash flow and generate revenue. That’s not to say that the return on investment needs to be immediate, but if there will likely be an extended wait, you should make sure you have enough capital on hand to continue paying off the advance in the interim.

2. Short-Term Nature

Like most financial tools, working capital advances were designed with a specific time frame in mind. They typically function as short-term loans, with repayment periods ranging from a few months to a year. As I mentioned earlier, they were made to help business owners with their day-to-day expenses, so they should only be used to meet immediate cash flow needs and bridge any gaps in your working capital management.

When taking out a working capital advance, ensure you have determined what the overall cost of capital is and have established a clear plan for repaying the loan within the agreed-upon time frame. Not doing this can result in falling behind on your payments or, even worse, defaulting on your loan, turning a tool for success into an albatross around your business’s neck.

3. Speed And Accessibility

As technology advances, the speed and accessibility of financial services have drastically improved. Applying for working capital advances has never been as efficient as it is today, as the application process has become faster with the help of underwriting technology. This can be beneficial for businesses that require immediate financing.

Many lenders also use soft credit pulls, so your credit score isn’t affected when you apply for financing.

4. Higher Cost

Everything comes at a cost, and working capital advances are no exception. They may come with higher interest rates and fees compared to traditional loans. Why? Well, this comes down to the short-term nature of these loans paired with the speed of funding and the potentially higher risk factors associated with the borrower’s creditworthiness.

You may find that lenders offering working capital advances may require a high credit score, which protects both the borrower and the lender from a potential default when attempting to pay back the borrowed amount. The lender may adjust the cost of accessing the capital to account for potential defaults when looking at the borrower’s creditworthiness, including factors such as any other business loans and average monthly revenue.

Other risk factors that lenders may use to determine the cost can be the volatility of the business’s revenue, as well as how verifiable the revenue is. There can also be risks in relation to the concentration of revenue, whether the revenue is coming from a large number of clients or whether only a small number of clients is bringing in the majority of the cash flow.

5. Proper Assessment Of Need And Repayment Capacity

Before pursuing a working capital advance, you should assess whether you actually need the financing and whether your business would be able to repay the loan. This will come down to the cost of capital and how much your business can truly afford.

It’s also crucial to decide if a working capital advance is the correct financial product for your business. If your business needs funding for a project that will not have a return on investment, it may be better to look into alternative financial products.

While working capital advances are short-term financial products, they can be used to push forward long-term projects as long as your business can afford to pay off the advance in the interim. As previously stated, working capital advances should be used for revenue-generating opportunities, so refrain from using them on large and lavish office parties or upgrading your office space.

Conduct a thorough analysis of cash flow, expenses, and revenue projections to determine the amount of working capital you need and ensure your business can comfortably meet the repayment obligations. The nice thing is that there is a wealth of resources out there that can help you determine how much working capital you need to run your business efficiently.

Working capital advances can be a smart way to keep your business moving—but only if used for the right reasons. Take the time to understand your true needs and repayment ability before borrowing, so your financing works for you, not against you. 

If you think capital advances may be a fit for your business, explore OwnerCo's lending resources for more information or to start the conversation with a lending expert.